The Global Financial Crisis Was Not Made in Washington

Later this week, finance ministers and central bank governors from around the world will assemble in Washington for the IMF and World Bank annual meetings. To a man (and a few women) they will be tempted to take a leaf from the playbook of the US presidential candidates and blame Washington for all the economic and financial the problems facing the world.

They should resist the temptation. The world is facing huge economic and financial problems, but blame for the crisis should not be placed on policies or nonpolicies formulated in Washington. At least not entirely.

A year ago, as the global financial crisis was already entering its third month, the finance ministers and central bank governors met and congratulated themselves for extending global growth of more than 4 percent into its fourth year, and for a similar prospect for 2008 and beyond. The self-congratulation was unjustified. The economic boom was too good to be true. It was fed by overly loose monetary and fiscal policies in the United States and by similar policies in other countries, all of which led to the global bust we are all experiencing. For example, Japan has had abnormal near-zero interest rates for essentially a decade. Short-term interest rates, adjusting for inflation, have been negative in many countries.

Easy money and benign economic and financial conditions were facilitated by global imbalances and distortions generated by the exchange rate policies of China and other countries that intervened in foreign exchange markets. In the process, these countries built up huge hoards of foreign exchange reserves and recycled those holdings back into the global financial system. Economists at the Bank for International Settlements came closest to the correct diagnosis.

Those facts do not excuse the weak macroeconomic policies that contributed to relaxed lending standards by banks and other financial institutions in the United States, other industrial countries and emerging market economies. As we now know, lax lending standards were not confined to subprime housing loans in the United States, or even US housing loans more generally. The problem was essentially universal.

Of course, risk management systems of financial institutions were short circuited by the greed of market participants (individual investors as well as institutions) and the blandishments of the financial engineers. National supervisors and regulators generally were not alert to these trends.

The global financial system does not have a single regulator or supervisor, and it is not likely to have one anytime soon. National authorities do cooperate, and collectively they misjudged the situation. Although some degree of regulatory arbitrage may have been involved, there is little evidence to support that proposition as a general cause of the crisis. Moreover, the task of regulators and supervisors is to say no, and few if any did so. In each case, they were consenting adults to the policies of their own financial institutions.

The finance ministers and central bankers assembling in Washington later this week face the most serious challenge since 1982, when they assembled in Toronto after the outbreak of the global debt crisis, which lasted almost a decade. Global growth was less than 1 percent in 1982 after two years of subpar growth. Slow growth continued into 1983. The major international commercial banks faced the prospect of their capital being severely impaired if not wiped out. The official and private sectors pulled together to forestall a complete collapse.

Today the global financial system is in worse shape than in 1982. As yet, the global economy is in better shape. However, the finance ministers and central bank governors meeting in Washington should not blame Washington; they should blame themselves. At their lavish receptions and dinners, they should collectively eat humble pie. They should direct their policies at heading off a global recession and agree that the crisis of confidence in financial markets requires strong countermeasures. They should resist remedial crisis prevention measures for the future until much more of the crisis is behind them. Talk about diagnoses and possible reform is appropriate, but action is premature.